A letter of credit is a bank’s promise to pay a seller once the seller ships goods and hands over the paperwork the deal requires. That single mechanism spins off into several distinct instruments, each built for a different risk or role in a transaction.
- Commercial LC (sight or usance): the workhorse for routine import/export payments; sight pays on presentation, usance pays later on a set date.
- Standby LC (SBLC): a backup guarantee, drawn only if the applicant defaults on a contract.
- Confirmed LC: adds a second bank’s payment guarantee, usually requested when the issuing bank’s home country carries political or credit risk.
- Transferable / back-to-back: used by trading intermediaries who don’t manufacture the goods themselves.
- Revolving LC: covers repeat shipments under one ongoing credit instead of a new document every time.
- Red clause / green clause: advances cash before shipment even happens, financing raw materials or warehousing.
More than 88% of world trade still relies on some form of documentary payment security, and letters of credit remain the most commonly used instrument for that job. The rest of this guide breaks down how each type works, what it costs, and when to reach for it.
Key Takeaways
Letter of credit types differ mainly by payment timing, guarantee purpose, and how many banks back the payment promise, and matching the type to the actual risk in a deal matters more than memorizing definitions.
| Point | Details |
|---|---|
| Sight vs usance | Sight LCs pay on document presentation; usance LCs defer payment to a set future date. |
| Standby is a guarantee, not a payment tool | SBLCs, often governed by ISP98, are drawn only if the applicant defaults on the underlying obligation. |
| Irrevocable is standard | Revocable LCs are considered obsolete and unsafe for beneficiaries; irrevocable credits are the norm. |
| Confirmation addresses bank risk | Request confirmation when you don’t trust the issuing bank’s jurisdiction or creditworthiness, not as a default upgrade. |
| Structure to role in the supply chain | Prominencebank supports multi-currency accounts and SBLC structuring for exporters, importers, and intermediaries managing LC-funded trade. |
Table of Contents
- Letter of Credit Types and How the Process Actually Works
- Commercial, Standby, and Confirmation: The Core Types Explained
- Specialized LC Structures: Transferable, Back-to-Back, and Revolving Credits
- How to Pick the Right Letter of Credit
- How Prominencebank Supports Letters of Credit and Trade Finance
- What the LC Guides Get Wrong
- Get Your Trade Finance Structure Right From the Start
- Sources
- FAQ
Letter of Credit Types and How the Process Actually Works
An LC involves more parties than most people expect, and each one carries a specific job. The applicant (usually the importer) requests the credit from their bank. The issuing bank commits to pay once conditions are met. The beneficiary (the exporter) ships the goods and submits documents. An advising bank in the beneficiary’s country authenticates the credit, and in some deals, a confirming bank adds its own payment guarantee on top of the issuer’s.
The process runs in a predictable sequence:
- Buyer and seller agree on LC terms in their sales contract.
- The buyer applies to their bank (the issuing bank) to open the credit.
- The issuing bank sends the LC to the advising bank in the seller’s country.
- The advising bank notifies the beneficiary, who ships the goods.
- The beneficiary presents shipping documents, invoices, and certificates to the advising or negotiating bank.
- The bank checks the documents against the LC terms for compliance.
- Once documents match exactly, payment is released, either immediately (sight) or on a future date (usance).
That fifth and sixth step is where most letters of credit actually fail. Banks pay against documents, not goods, and a single typo in a bill of lading, a mismatched date, or a missing certificate of origin can trigger a documentary discrepancy that delays or blocks payment entirely. This strictness is intentional: the International Chamber of Commerce’s UCP 600 rules, adopted by banks worldwide, treat documents as the sole basis for payment, independent of whether the underlying goods actually showed up in good condition.
Standby letters of credit follow a different rulebook. Because UCP 600 doesn’t address every standby-specific issue, most SBLCs are issued subject to ISP98, the International Standby Practices published by the ICC specifically for these guarantee-style instruments. That distinction matters when you’re drafting draw conditions, since ISP98 language and UCP 600 language aren’t interchangeable.
Pro Tip: Before you sign a sales contract that specifies an LC, ask your bank to review the draft LC terms first. Catching a documentary mismatch before the credit is issued costs nothing; catching it after shipment can cost you the whole payment.
Commercial, Standby, and Confirmation: The Core Types Explained
Most trade professionals only need to master four distinctions to navigate the bulk of real-world deals: sight versus usance, commercial versus standby, irrevocable versus revocable, and confirmed versus unconfirmed.
Sight LC vs usance LC
A sight LC pays the beneficiary as soon as compliant documents are presented, typically within a few banking days. Exporters who need cash flow fast, or who don’t extend credit terms to new buyers, favor sight credits.
A usance LC (also called a deferred payment or term credit) delays payment to a set future date, often 30, 60, or 90 days after shipment or document presentation. Documentary credits are a definite payment undertaking either way. The difference is timing, not certainty: usance simply gives the buyer breathing room to sell or process the goods before paying, which is common in commodity trading and manufacturing supply chains where the buyer needs the inventory turned over first.
Standby LC (SBLC)
A standby functions closer to insurance than a payment mechanism. Under a commercial LC, the bank expects to pay; under an SBLC, the bank hopes it never has to. The beneficiary only draws on it if the applicant fails to perform, whether that means missing a payment, failing to deliver a service, or breaching a contract term.
Three SBLC variants come up constantly in construction and cross-border services:
- Performance standby: guarantees the applicant will complete contracted work, common in construction and engineering contracts.
- Bid standby: backs a bid or tender submission, assuring the project owner the bidder won’t walk away if awarded the contract.
- Financial standby: guarantees repayment of a loan or financial obligation, often used to backstop credit lines.
Businesses reach for an SBLC instead of a commercial LC when the underlying deal isn’t a straightforward sale of goods. If you’re bidding on a government contract or backing a lease obligation, a standby fits. If you’re paying for a container of machine parts, a commercial LC fits better. Prominencebank’s SBLC resource walks through how these guarantees get structured for institutional clients.
Irrevocable vs revocable
An irrevocable LC can’t be changed or canceled without agreement from every party involved: applicant, issuing bank, and beneficiary. A revocable LC technically allows the issuing bank to amend or cancel it without the beneficiary’s consent, which sounds efficient until you realize the beneficiary has almost no protection.
Practitioners treat revocable letters of credit as effectively obsolete, and for good reason. If your bank can cancel the payment guarantee at will, you’re back to trusting the buyer’s word, which defeats the entire purpose of using an LC in the first place. Nearly every LC issued today is irrevocable by default, and most banks won’t even offer a revocable option without significant pushback.
Confirmed vs unconfirmed
An unconfirmed LC carries only the issuing bank’s promise to pay. A confirmed LC adds a second bank, usually one in the beneficiary’s own country, that independently guarantees payment even if the issuing bank can’t or won’t pay.
Beneficiaries request confirmation when they don’t fully trust the issuing bank’s creditworthiness, or when the issuing bank operates in a jurisdiction carrying elevated political or currency risk. Confirmation isn’t free. It typically adds a percentage-based fee on top of standard issuance costs, and the confirming bank will run its own credit assessment before agreeing to add its name to the guarantee. For exporters shipping into markets with unstable banking systems, that fee is usually worth paying.
Specialized LC Structures: Transferable, Back-to-Back, and Revolving Credits
Beyond the core categories, several structural variations solve specific financing problems that come up constantly among intermediaries, distributors, and repeat suppliers.
- Transferable LC: lets the original beneficiary (often a trading company or middleman) transfer some or all of the credit to a second beneficiary, typically the actual manufacturer. Banks usually cap how many times a credit can be transferred and often restrict transfers to the original amount and terms.
- Back-to-back LC: instead of transferring the original credit, the intermediary uses it as collateral to have their own bank issue a brand-new, separate LC to the actual supplier. This second credit is legally independent of the first, which creates real risk: if the buyer’s LC falls through for any reason, the intermediary is still on the hook for the supplier’s credit.
- Revolving LC: stays open across multiple shipments over a set period instead of requiring a new LC for every transaction. Manufacturers with recurring buyers use revolving credits to cut down on repeated paperwork and issuance fees.
- Red clause LC: permits the beneficiary to draw an advance before shipping, against a signed receipt, historically used to finance the purchase of raw materials like coffee, cotton, or wool ahead of harvest or production.
- Green clause LC: extends the red clause concept further, advancing funds that also cover warehousing and insurance costs while goods sit in storage awaiting shipment.
- Instalment LC: schedules shipments and payments across a defined timeline rather than one lump transaction, useful for large orders delivered in phases.
The distinction between transferable and back-to-back credits trips up more people than it should. Transferable structures move entitlement under the same original credit; back-to-back structures create a second, independent credit backed by the first. If you’re an intermediary trying to decide which one to request, transferable is generally cheaper and simpler, but only works if the original LC explicitly permits transfer and the buyer’s bank agrees to the terms.
Instalment credits carry a risk that catches first-time exporters off guard: if one shipment instalment misses its scheduled window, the entire credit can become unavailable for the remaining instalments, not just the late one. That’s a harsh penalty for a shipping delay outside your control, so anyone negotiating an instalment LC should push for realistic shipping windows before signing.
Pro Tip: If you’re a manufacturer supplying a trading company, ask upfront whether your credit will be transferable or back-to-back. It changes who bears the risk if the buyer’s financing falls apart.
How to Pick the Right Letter of Credit
Choosing among letter of credit types comes down to five practical questions, and answering them in order will point you toward the right structure faster than reading every clause of UCP 600 cover to cover.
- How well do you know the counterparty? New or distant relationships lean toward confirmed, irrevocable commercial LCs. Established, repeat relationships can often work with unconfirmed credits or even revolving structures.
- What’s the transaction size and frequency? One-off large shipments call for a standard commercial LC. Recurring smaller shipments to the same buyer are better served by a revolving LC that avoids reissuing paperwork every cycle.
- Do you need a guarantee rather than a payment tool? If the underlying obligation is performance, a bid, or a loan backstop rather than a sale of goods, a standby LC is the correct instrument, not a commercial one.
- Do you need financing before shipment? Suppliers who need cash for raw materials or production costs before goods ship should look at red or green clause structures.
- What’s your role in the supply chain? Intermediaries and trading companies need transferable or back-to-back arrangements; direct manufacturers usually don’t.
On cost, banks typically layer issuance fees, confirmation fees, and negotiation fees, often charged as a percentage of the LC value plus fixed processing charges. The applicant usually pays issuance costs, while confirmation fees are frequently negotiated between buyer and seller as part of the underlying sales contract; who actually absorbs that cost varies by deal and market leverage.
Timing depends heavily on structure. A standard sight LC can move from application to payment in a matter of days once documents are in order, while usance credits build in the agreed deferral period on top of that. Confirmation and cross-border verification steps add time, particularly when payment rails between correspondent banks cross multiple time zones and clearing systems. If your counterparty relationship doesn’t justify the added cost and delay of confirmation, a documentary collection or a straightforward bank guarantee may serve the deal just as well.
How Prominencebank Supports Letters of Credit and Trade Finance
Trade finance instruments only work as well as the bank standing behind them, and that’s where a lot of exporters get stuck choosing between a slow legacy institution and a faster digital option that still meets compliance standards.
Prominencebank operates as a fully licensed digital bank built for exactly this kind of cross-border complexity. Its trade finance capabilities include:
- Multi-currency business accounts that let clients receive LC-funded payments in the currency the contract actually specifies, without forced conversion delays.
- Support for standby letter of credit structures for clients who need performance or financial guarantees rather than straight payment instruments.
- AML/KYC compliance built into onboarding, aligned with international standards trade finance counterparties expect to see before they’ll issue or confirm a credit.
- A dedicated trade finance service line covering documentary instruments and related bank instruments beyond LCs.
Before applying for an LC through any trade finance bank, gather your commercial invoice templates, shipping and insurance documentation history, and corporate formation paperwork. Prominencebank’s step-by-step account setup guide outlines what documentation international clients typically need before an account, and the LC facilities tied to it, can move forward.
What the LC Guides Get Wrong
Most explainers treat letter of credit types like a vocabulary list: here’s a definition, here’s another definition, memorize them. That misses the actual decision most traders face, which isn’t “what is a transferable LC” but “does my role in this deal need one.”
The confirmation question gets underrated the most. People treat confirmed LCs as an upgrade you buy if you can afford it, when it’s really a risk instrument tied to a specific fact pattern: an issuing bank whose creditworthiness or jurisdiction you can’t fully vouch for. If that fact pattern doesn’t apply, paying for confirmation is wasted money. If it does apply and you skip it, you’re exposed exactly when you can least afford to be.
The other gap is instalment risk. Sellers negotiate shipment schedules assuming smooth execution and rarely build in slack for the possibility that one late instalment voids the rest of the credit. That single clause deserves more negotiating attention than most of the boilerplate around it.
Prioritize matching the instrument to your actual exposure, not to whichever type sounds most sophisticated on paper.
— Harold
Get Your Trade Finance Structure Right From the Start
Choosing the correct letter of credit type only pays off if the bank behind it can actually execute, confirm, and settle across the currencies your trade partners use. Prominencebank gives international businesses and high-net-worth principals a fully digital path to multi-currency accounts, trade finance support, and SBLC structuring, without the weeks of legacy paperwork that traditional correspondent banking often demands.
That matters most for exporters juggling payments in several currencies at once: converting every incoming LC settlement back to a home currency erodes margin on every deal. A multi-currency business account lets you hold and disburse funds in the currency your contract specifies, right alongside the trade finance facilities that back the credit itself. If you’re preparing to open, confirm, or receive payment under a letter of credit, start by reviewing account requirements on Prominencebank’s trade finance page and get your documentation moving before your next shipment deadline.
Sources
- Letter of Credit
- Types of Documentary Credit: A comprehensive guide — ICC Academy
- Letter of Credit — Investopedia
- Revocable LCs and UCP 600 commentary — AustLII
FAQ
What are the four main types of letters of credit?
The four most commonly cited types are commercial (sight and usance), standby (SBLC), confirmed, and revolving letters of credit, each addressing a different payment timing or risk need.
What’s the difference between an SBLC and a regular LC?
A commercial LC is expected to be drawn as the primary payment method for a sale, while a standby LC acts as a backup guarantee, drawn only if the applicant fails to perform.
Is a revocable letter of credit ever a safe choice?
Rarely. Practitioners consider revocable LCs effectively obsolete because the issuing bank can cancel or amend the credit without the beneficiary’s consent, so nearly all LCs issued today are irrevocable.
When should a beneficiary insist on a confirmed LC?
Insist on confirmation when you don’t trust the issuing bank’s creditworthiness or it operates in a jurisdiction carrying higher political or banking risk, since confirmation adds a second bank’s independent payment guarantee.
Does Prominencebank help clients set up an SBLC?
Yes. Prominencebank supports standby letter of credit structuring alongside multi-currency accounts for clients who need performance, bid, or financial guarantees rather than a standard commercial credit.